Japan & Korea: Domestic Reform & Geopolitical Shifts

December 8, 2010

William Overholt
, Senior Research Fellow, Harvard University Kennedy School of Government

Robert Fallon
, Adjunct Professor, Columbia Business School; Director, Japan Society & The Korea Society

William Overholt, a Senior Research Fellow at Harvard's Kennedy School, visited Japan Society to discuss the paths taken by Japan and South Korea since the 1990s and their implications for economic revitalization and the region's politics.

"The U.S.-Japanese alliance and the Asian miracle created by Japan were what saved Asia and the world from the spread of communism. Without the great economic takeoffs, all of American military power would have been absolutely useless in a place like Indonesia. So, together we saved Asia, and that has obviously created deep bonds at many levels," Dr. Overholt said.

After World War II, Japan was faced with internal instability and the threat of the Soviet Union, he continued. "This led to a willingness to do whatever was necessary to survive, and that meant reaching out and globalizing by adopting best practice wherever it came from." For instance, it adopted Deming's quality control procedures and some of General Electric's labor management practices and improved upon them. It was also ruthlessly proactive about adjusting to market changes. Thus for example when energy prices rose and it became uneconomic for Japan to keep in place its basic aluminum industry, "MITI shoved it offshore."

Japan became the first country ever to grow at 10 percent year after year, and its neighbors began to follow the lessons of Japan's success. "Many years after Japan, Deng Xiaoping looked around, looking particularly to South Korea and Taiwan, and said, 'Why is everybody else doing better than we are?' and he basically copied the basic principles that had been learned from the other Asian countries."

What Japan introduced in Asia was a mobilization system, which is very effective when a country is preparing for war, recovering from war, initiating economic growth, or managing a crisis, Dr. Overholt said. However, "what the mobilization systems are not good at is managing a very highly complex modern economy in normal times."

By 1975, a confident and prosperous Japan began to subsidize troubled industries instead of pushing them offshore or shutting them down. "We evolved from the situation where construction companies were building absolutely vital roads between major Japanese cities to one where the politicians were giving them money to pave every stream and river in Japan."

When the bubble collapsed in 1990, these "deep political and economic management trends" turned what would otherwise have been half a decade of "lost years" into two lost decades. Though Japan's demographic slowdown is "a fundamental obstacle to really fast growth," it's the focus of politicians protecting inefficient industries and agriculture, on limiting competition, on the past, on sustaining inefficient expenditures like the overbuilt Post Office system, that "is really behind the slowdown," Dr. Overholt said.

The DPJ's victory in 2009 doesn't change things, for the party is a conglomeration of "basically all the people who didn't like the LDP," and as such lacks "a coherent view of the world."

A decade ago, China's economy was much smaller than Japan's, but China had more trade with its neighbors and more investment ties with the rest of the world than did Japan. Thus, China's "influence came to exceed Japan's even before its economy was as large as Japan's," he said.

Meanwhile, South Korea, with many of the same problems that hobble Japan, "was reforming just a little bit faster." According to a forecast by Rick Katz of The Oriental Economist, in 2011 South Korean incomes will be 88 percent of Japan's in purchasing power terms, and by 2015 will exceed Japan's, Dr. Overholt said. "This tremendous shift in the relationship between South Korea and Japan is fundamentally affecting American policy; it's fundamentally affecting all the power balances in Asia."

American attention to China was much criticized in Japan, notably when President Clinton visited China in 1998 and did not stop in Japan. President George W. Bush tried to swing the pendulum in the other direction and to restore the U.S.-Japan alliance to its proper, Cold War role. "But it didn't work," he said. Frustrations grew over the Futenma base issue, North Korea, Japan's lingering economic woes, and its alienation of its neighbors over the history issues. American relations with South Korea were also unhappy; "the president of Korea was a difficult ally for us, and our defense secretary was a very difficult ally for them."

China's attitude towards the U.S.-Japan alliance changed with the 2005 "2 + 2" Agreement, which "brought Taiwan explicitly under the alliance," Dr. Overholt said. Previously, "the Chinese had privately said, 'Look, we understand your bases, your alliances are what maintains stability in Asia, and stability is what we need for our economic development." After the agreement, the Chinese attitude was that "the U.S.-Japan alliance and all these bases are a gun pointed at us and we don't like it," though "under Obama that has shifted back."

Over the past several years, China and the U.S. have cooperated on a range of issues, from North Korea to the war on terror, regional crime and drugs, and thus "China and the U.S. had a quite useful relationship," whereas "Japan was kind of on the sidelines" if not in opposition, he said. And "the lesson of the global financial crisis, at least initially, was there are two countries in the world which can take big decisions quickly and fix huge global problems, and those are the U.S. and China. Europe couldn't it, India couldn't do it, Japan couldn't do it."

The Taiwan issue, which had been "the big issue between the United States and China," was eased by the presence of a new administration in Taiwan and policy changes in Beijing, and "Secretary Gates drastically cut the part of the defense budget that was directed at China."

However, the Obama administration's early optimism about the relationship with China gave way to a "sense of betrayal" over China's lack of cooperation at the Copenhagen climate change summit. The Chinese dragged their feet on Iran sanctions. They set up new rules on foreign direct investment, providing that "basically if you want to do business in our market, you give us all your technology. And that's not what Japanese or European or American business executives thought the deal was. 'Our markets are open. We don't require the Chinese to give up all their secrets in order to operate in our markets.' So, this had a very fundamental consequence."

"Chinese policies in the last two years have absolutely destroyed the business lobby," which had brought the U.S., Europe and China together in important ways, Dr. Overholt said. In reaction to Obama's "absolutely innocuous arms sale to Taiwan," China had "a huge fit" and cut off all military-to-military ties. Beijing failed to react to North Korean sinking of a South Korean navy ship and to shelling of civilians at YongPyeong, and was assertive in pressing claims in the Yellow Sea, the Senkakus and the South China Sea. Admittedly, India's claims to territorial waters have been even broader, so the situation "is not entirely one-sided," he said.

"But the Chinese have fundamentally changed the equation. And this has revitalized the spirit of the U.S.-Japan Alliance," though "it hasn't really changed many of the underlying fundamentals."

"If there is any consensus in American foreign policy, it's that everybody wants Japanese economic success, everybody wants a very influential Japanese role in Asia, and everybody wants a strong American-Japanese alliance. But there is also a consensus that the Japanese end of the alliance at this point is pretty weak and pretty ineffectual."

"If you go to Tokyo, everything is working. Everybody looks good... But underneath, what's going on reminds me of Thoreau's famous sentence: Most men lead lives of quiet desperation. Anybody who is 45 or 50 years old in Japan knows they're not going to get the full value of their pension. The value of their home went down 11 percent last year, and the value of their stocks is going nowhere. The stock market is about a third of where it was back in the 80s. People are alienated from the political system."

Can Japan revive? he asked. The country has many assets, from an educated populace to excellent technology to disciplined organizations to standards of civility that surpass anyone else in the world. Its revival will take "more globalization, more competition, painful shakeouts in the interest of efficiency, very importantly giving women a full role in the economy. And the balance of income needs to shift. Japan has very rich companies, very poor consumers, and very poor government--impoverished I should say. The balance has to shift in favor of the consumers."

Can these changes take place without a great crisis? "The system needs a big-enough shock to shatter the system. The question is how much of a shock. Hopefully small. But we're still not seeing a single major politician that's saying, 'This is my agenda. This is what will fix Japan, looking to the future rather than to the past.'"

A decade or so ago, Japan and Korea "had essentially similar problems: a great national financial crisis, tremendous national security fears over North Korea and an imminent demographic decline. And the only distinguishing thing was that Korea had significantly worse problems in each of these areas."

Korea, though not as globalized as some of its smaller neighbors, "has done just enough: stronger bank reforms, a more open economy, importing labor including a million central Asians and a lot of Filipinos and Indonesians, transformed the role of women, so the workforce is expanded enormously." Its two parties have genuinely different agendas and give voters clear influence over major policy choices. "The result is vigorous economic growth, stock market doing good things, major companies advancing almost across the board, and a very strongly rising international influence."

"My pet theory is that when Korean incomes pass Japanese incomes in 2015, that that will mobilize Japan to really do some soul searching and undertake some very serious reforms," Dr. Overholt concluded. "I think the fundamental recognition--and this is one that China is going to face big time in a few years--is that the mobilization system is fundamentally unsuited to success in the modern world, and you have to move on. The thing about South Korea and Taiwan is that they moved on. Japan and China both face tremendous political difficulties in moving on."


Presider Robert Fallon of Columbia Business School asked the first question:

Could the crisis that would spur Japan to action be some sort of crisis taking place between Japan and China?

"It's conceivable," but "my fear would be that these minor crises with China will provide a diversion from the fundamental necessity of domestic economic reform," Dr. Overholt replied.

Audience members joined the Q&A:

Can you identify Japanese business leaders today who are trying to rally different parts of the business community to help shock the Japanese system?

"I think the Japanese business community is very divided. I think there are many powerful companies that benefit at least in the short run from all the protections and lack of competition of the old order," Dr. Overholt said.

In the business community and the think tanks "are some of the most forward-thinking, insightful people on earth... What they need is they need a leader and they need a vehicle to rally around. And I'm sure that will come one of these days. But right now you've got all of this intellectual dynamism, but it can't take over and run the place yet."

If China sees the U.S. as in a long-term decline as a result of the financial crisis and slow recovery, to what extent do political and business leaders in Japan and Korea share that view?

The assessment of the U.S. situation in Japan, Korea, Singapore and elsewhere "is probably more proportionate to the reality," Dr. Overholt replied. Among other things, the power struggle over the succession in China "tends to lead toward an excessively tough foreign policy."

How can unification between South Korea and North Korea be achieved, and how realistic is it to expect it to take place?

Park Chung-hee focused on the economy, Dr. Overholt said. "He cut the military way back. At the time North Korea was much stronger than South Korea in every respect. Park Chung-hee's economic priorities have meant that now South Korea's economy is 20 to 30 times as big as North Korea's."

"To me North is like the bubble in Japan, or the American housing bubble. These things go on for a very long time, and you never know when the bubble is going to burst... I think we're coming to the end of the game with North Korea. The costs to China of subsidizing Pyongyang are going to go up asymptotically. The ability of a 29-year-old kid to keep things together where people are starving and becoming aware of how good things are in China and South Korea, and to deal with these generals who want more and more, must be limited. I just don't think it works."

--Katherine Hyde
Topics:  Policy

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